PRIMA 8006 PRM Certification - Exam I: Finance Theory, Financial Instruments, Financial Markets – 2015 Edition Online Training - Page 10 of 11

Question #91

An investor expects stock prices to move either sharply up or down.

His preferred strategy should be to:

A . buy a butterfly spread
B . buy a condor
C . buy a collar
D . buy a straddle

Question #92

For a forward contract on a commodity, an increase in carrying costs (all other factors remaining constant) has the effect of:

A . increasing the forward price
B . decreasing the forward price
C . increasing the spot price
D . decreasing the spot price

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Question #93

What would be the expected return on a stock with a beta of 1.2, when the risk free rate is 3% and the broad market index is expected to earn 8%?

A . 7%
B . 7.4%
C . 9%
D . 9.6%

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Question #94

Which of the following statements are true:

I. A credit default swap provides exposure to credit risk alone and none to credit spreads

II. A CDS contract provides exposure to default risk and credit spreads

III. A TRS can be used as a funding source by the party paying LIBOR or other floating rate

IV. A CLN is an unfunded security for getting exposure to credit risk

A . I, III and IV
B . II, III and IV
C . II and IV
D . II and III

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Question #95

An investor enters into a 4 year interest rate swap with a bank, agreeing to pay a fixed rate of 4% on a notional of $100m in return for receiving LIBOR.

What is the value of the swap to the investor two years hence, immediately after the net interest payments are exchanged? Assume the 2 year swap rate is 5%, and the yield curve is also flat at 5%

A . $1,859,410
B . $1,904,762
C . -$1,859,410
D . -$1,904,762

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Correct Answer: A
A

Explanation:

The swap can be valued by using the new swap rate of 5%. The investor is paying fixed and receiving LIBOR, and can effectively get out of his position by entering into a swap to receive 5% and pay LIBOR. This will leave him/her with a net cash flow of 1% for two years, ie $1m for 2 years that can be discounted to the present using the rates provided, ie =(1/1.05 + 1/(1.05^2)) = $1,859,410.

Detailed explanation:

An Interest Rate Swap exchanges fixed interest flows for floating rate flows. The floating rate leg is tied to some reference rate, such as LIBOR. The parties exchange net cash flows periodically. Conceptually, an interest rate swap is the combination of a fixed coupon bond and a floating rate note. The party receiving the fixed rate is long the fixed coupon bond and short the FRN, and the party receiving the floating rate is long the FRN and short the fixed coupon bond.

An interest rate swap can be valued as the difference between the two hypothetical bonds. FRNs sell for par at issue time as they pay whatever the current rate is, subject to periodic resets. Therefore immediately after a payment is made on a swap, the value of the FRN component is equal to its par value. The bond can be valued by discounting its cash flows. The difference between the two represents the value of the swap. When the swap is entered into, the fixed rate leg is set in such a way that the value of the hypothetical bond is equal to that of the FRN, and the swap is valued at zero. The rate at which the fixed rate leg is set is called the swap rate. Over its life, market rates change and the value of the fixed coupon bond equivalent in our swap diverges from par (whereas the FRN stays at par – at least right after payments are exchanged and the new floating rate is set for the next period). Thus the swap acquires a non-zero value.

There are two ways to value a swap. If interest rates for the future are known, the bond and the FRN can be valued and their difference will be equal to the value of the swap. Sometimes, the current swap rates are known. In such a case, the swap can be valued by imagining entering into an opposite swap at the new swap rate, which will leave a residual fixed cash flow for the remaining life of the swap. This residual cash flow can be valued and that represents the value of the swap. For example, if a 4 year swap was entered into exchanging an annual fixed 5% payment on a notional of $100m for a floating payment equal to LIBOR, and at the end of year 1 the swap rate is 6%, then the party paying fixed can choose to enter into a new swap to receive 6% and pay LIBOR. All cash flows between the old and the new swap will offset each other except a net receipt of 1% for the next 3

years. This cash flow can be valued using the current yield curve and represents the value of the swap.

Question #96

Which of the following expressions represents Jensen’s alpha, where is the expected return, is the standard deviation of returns, rm is the return of the market portfolio and rf is the risk free rate:

A . https://www.riskprep.com/images/stories/questions/102.12.b.png
B)
https://www.riskprep.com/images/stories/questions/102.12.d.png
C)
https://www.riskprep.com/images/stories/questions/102.12.c.png
D)
https://www.riskprep.com/images/stories/questions/102.12.a.png
B . Option A
C . Option B
D . Option C
E . Option D

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Question #97

When graphing the efficient frontier, the two axes are:

A . Asset beta and standard deviation of the market portfolio
B . Expected return and asset’s beta
C . Portfolio return and market standard deviation
D . Portfolio return and portfolio standard deviation

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Question #98

Backwardation can happen in markets where

A . convenience yield is less than the total interest and carrying costs
B . convenience yields are greater than the total interest, storage and other carrying costs
C . convenience yields are positive
D . convenience yields are zero

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Question #99

If the spot price for a commodity is lower than the forward price, the market is said to be in:

A . contango
B . backwardation
C . a short squeeze
D . disequilibrium

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Question #100

The cheapest to deliver bond for a treasury bond futures contract is the one with the :

A . the lowest yield to maturity adjusted by the conversion factor
B . the lowest coupon
C . the lowest basis when comparing cash price to the futures spot price adjusted by the conversion factor
D . the highest coupon

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PRIMA 8006 PRM Certification – Exam I: Finance Theory, Financial Instruments, Financial Markets – 2015 Edition Online Training